This report provides in-deep analysis of the currency hedge of Markel Corporation, which has the exported business. Method of case study and theory analysis were used. The results show that the current hedging method is not fit for Markel Corporation as the high economic risk, such as the complexity and unpredictability. As the company is a family small and medium-sized enterprise, which has low capacity to fight high exchange risk, which is hardly for the company to improve the performance if it adopts the currency hedging in the current economic situation. Other than currency hedging, some measures can also be accepted: foreign exchange in advance or delay and using the insurance system. It is proved that the insurance system is benefit for the Markel Corporation in the current situation.
Case summary
Markel Corporation is a family corporation operating tubing making and sailing. The company owns overseas market share-40% of the products is exported. Thus, one of the risks of the business operation is foreign exchange risks. In order to decrease the foreign exchanges, the company takes some measures: Firstly, it charges customers stable price in their own currencies. Secondly, it purchases forward contracts from PNC Financial Services Group in Pittsburgh. There are both advantages and disadvantages existing in the two financial methods. At first, charge customers stable price in their own currencies can decrease the losses of the company. However, it may also lead to the price of the commodities higher than other corporations, which limit the competitiveness of the company in the international market. The method of forward contracts is adopted to avoid economic losses. The forward contract double-edged sword: on the hand, forward contracts have many advantages: it can decrease the risk of currency fluctuations in a certain extent; transform the uncertainty of exchange rate changes into quantifiable factors which are conducive to cost accounting, and can also eliminate the time risk and value risk. On the other hand, as forward contracts has the property of flexibility and generality, which my lead to large losses. During 2000-2002, Markel swallowed more than $650,000 in currency losses. Consequently, Markel employees had to endure pay cuts, and the firm had to redouble its efforts to boost efficiency and cut costs.
The purpose of this paper is to analysis whether the forward contract is worth for Markel to use. Then, it will analysis if the company can improve its economic performance by using the current currency hedging. Last, the author will introduce other methods to fight for the foreign exchange rate which Merkel can adopt in the current economic situation.
Currency hedging is not worth for Markel
Nowadays, with the rapid development of the economic globalization, more and more corporations are arising in the international market (Wolfgang K., 2009). In order to get further development and enlarge the international market sharing, it is important for those companies to choose a suitable and scientific financial management method to fight for all the financial risks, which requires the corporation not only ensuring the safety of company funds, but also using the funds effectively to maximize profits (Bjorgan, R. et.al., 1999). Forward contact is a kind of tool to fight the uncertainty of exchange rate.
Forward foreign exchange contracts refers to that contracting parties of foreign exchange reach an agreement in advance on the currency, amount, exchange rate and the delivery deadlines and finalized in the form of contracts (Carol L. O., 2008). The contracting parties will perform the contract in the delivery date： 交割é™æœŸ-；延期决--；展é™-期，交割é™æœŸ-；交割é™æœŸ-(英国交易所) and fulfill the contract. The main purpose of forward contract is to compensate the real price risk in the future. Both the exported enterprises and the imported enterprises can enter into forward contract with banks, and deliver with the forward price in the appointed day. The forward contract has many advantages: it can decrease the risk of currency fluctuations in a certain extent; transform the uncertainty of exchange rate changes into quantifiable factors which are conducive to cost accounting, and can also eliminate the time risk and value risk (Stefan R. and Taylo M. P., 2008). However, every coin has its two sides, In order to illustrate the disadvantages and investigate that whether the forward contract is suitable for the company, it is necessary to study the risk factors of the forward contract.
First, the forward contract has the risk of hardly to predict, which may cause economic losses for the international trade corporation. As the forward contract make agreement on the exchange rate, both parties are involved to bear the risks from the flotation of exchange rate, which will lead to instability and intangibilities of profit and loss of the foreign trade enterprise, and effect the financial position and business performance (Torben G. A., 2007). The exchange rate movement can be effected by many factors-the international balance of payment of the country, currency inflation, the balance of the supply and demand, economic development, the political and economical relationship with other countries, economic cycle, economic policy and exchange policy (Christopher J. N.,2009). Those factors result in many uncertain affects of the foreign currency exchanges. No one can predict the future trend without professional and scientific research.
Second, the forward contract requires the corporation to sign the contract at least 3 months, which increased the risk of the currency exchange as the complexity and unpredictability of the forward contract.
Third, forward contract has the risk of credit, which may also lead to losses. The forward contract has no fixed place and counter party, each of the participators needs to find suitable object for transaction (Wolfgang K., 2009). Therefore, once one of the participator has non-credibility, the other corporation will suffer a lot. Those risks can increase the unpredictability of the forward contract.
From the discussion above, one can conclude that the forward contract with the risks of high flexibility and generality, no centralization of trading and counter party risk. And the most obvious characteristic of those risks from currency is uncertain and hardly to predict. Thus, the disadvantage of the forward contracts is flexibility and generality, which my lead to large losses.
As a small and medium-sized enterprise family corporation, it is not worth for Markel to choose forward contract-not only because of the limited ability to fight high exchange risks, not also because short of professionals to give suggestions.
Markel can't improve the performance of its currency hedging in the current situation
As 40% of the sales are exported, the business performance is seriously affected by the rate of Euro/dollar, which is effected by the political risk, credit risk and currency risk. As we all know that dollar, the world currency, is the keyword of the recent financial crisis -it is the increasing accumulation of contradictions in the international monetary system that triggered the crisis in the final (Kaufmanna D. et.al., 2007). The subprime mortgage crisis in U.S. accelerated the depreciation of the dollar. In order to deal with the crisis, the U.S has made some politics: firstly, raising 700 billion dollars to implement the rescue plan by issuing bonds, which lead to large expansion of the dollar circulation; secondly, the FED cut the federal funds rate to nearly zero interest rates, which will result in U.S dollar sinks in the future; thirdly, the new U.S. president Barack Obama proposed to take expansionary fiscal policy, which make the huge budget deficit worse, which will lead to dollar weaker in the medium and long term (Donghui L., 2009).
Meanwhile, the subprime mortgage crisis serious affected other countries. After that, in order to recover their economic development, all influenced countries began to take measures to recovery, but as the recovery of the major developed economies is instability and inconsistency, which lead to the unsuitability of the EUR/USD.
Therefore, it still exist unpredicted flotation before the economic development of occident become stability.
Other currency management strategies Markel can choose
To defend the flotation of the foreign exchange, it is important for an export-intensive corporation. In fact, there are several currency management strategies to protecting exported corporation from exchange rate risk: hedging transactions, foreign exchange in advance or delay, enter into exchange proviso clause, using the insurance system and hedging in the credit market or money market (G. David H., 2000).
Foreign exchange in advance or delay is that change the date of deliver. There are two usually used methods: first, when the settlement currency trends down, the exported enterprises should shorten the credit period as soon as possible; when the settlement currency trends up, the exported enterprise should delay the receipt. The import enterprises are on the contrary. Secondly, when the settlement currency rises, the import corporation should take delivery ahead of time; when it drops, the export company should try to postpone delivery. The export company should try to postpone delivery or sign the export contract earlier according to the rise or drop of the currency (Stefan R. and Taylo M. P., 2008). Foreign exchange in advance or delay can still decrease the exchange risk, but it my faced the problem of unhappy cooperation, as the risk was transformed into the corporative corporation (Jeffrey F., 2010).
Insurance is a certain way for decrease the losses. The corporation insures according to the rules pay the fees to the insurance corporation. When the company suffers the economic losses, they can claim from the insurance corporation. Foreign trade enterprises can relieve the risk of loss, especially in the period of economic instability.
Thus, insurance is a feasible way to defend the flotation of the foreign exchange rate.
Conclusion
Markel Corporation is a small and medium sized export corporation. In order to decrease the losses from the flotation of foreign exchanges rate, it purchased the forward contract. However, it can be seen that forward contract is not worth for the compay: it has the risk of unpredictability as too many influenced factors; meanwhile, the company has less capacity to bear the risk and the company is short of professionals to give suggestion. Further, the forward contract can't improve the corporation performance. Firstly, dollar continued to drop in the economic crisis. Secondly, as the influence of the economic crisis, the recovery of the America and Europe is unsynchronized, which will lead to it continues to shocks of the Eur/Usd. Last, in order to ensure Markel can get stable development and decrease the foreign exchange movement under the influence of economic crisis, it is benefit for the company to inter the insurance system.
